Why an emerging-markets crash wouldn’t matter

MatthewLynn

Bloomberg

China is being engulfed in a financial crisis that might end up in its own version of the credit crunch. There are running battles on the streets on Bangkok and Kiev as authoritarian regimes totter. Turkey is sinking, and may soon not be able to fund its current account deficit. Argentina is going through another currency crisis. There is no shortage of drama coming out of the emerging markets. And there is no shortage of reasons for the markets to work them themselves up into a panic.

But hold on.

Perhaps an emerging-markets crash does not matter nearly as much as investors seem to think. Why not?

There are three reasons. First, while most are huge exporters, few are major importers, except of raw materials. So even if they slow down, it will not hit the developed world. Second, falling currencies will help them rebalance their economies, and export more, not destroy them. Finally, while there are inevitable storms along the way, most emerging markets are still growing very fast. China is expanding at 7.7% this year. Crisis-hit Turkey should grow at 4%. Overall, emerging markets growth is accelerating this year, not slowing down.

Panics over emerging markets are as inevitable as winter snowstorms. Smart investors will sit them out, and let them blow over — and selectively use them as a buying opportunity.

There were wobbles in the emerging markets at the close of 2013, but at the start of 2014 it has turned into a full-scale panic. All the emerging markets are now down for the year, and the impact of that has been felt in the developed world as well, with markets in the U.S. and Europe sharply down. The Istanbul Index
XU100, -1.63%
is down from 74,000 last month to 64,000 this, and the rout has been a lot worse for foreign investors as the currency has gone into free fall as well. The Argentine index dropped by almost 4% on Monday alone. Overall, the MSCI Emerging Markets Index
891800, +0.48%
lost almost 2% on Monday, even though it was already at four-month lows.

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The decision by the Federal Reserve to start ‘tapering’ the amount of money it releases into the markets every month was the immediate trigger for the meltdown. Whether quantitative easing does much for a domestic economy remains to be proven one way or another. But what it certainly does is pump up the financial markets, and flood the world with easy cash. A lot of that money found its way into the emerging markets, usually in search of a higher yield than it could find at home. As the taps get turned off, it is hardly surprising that indexes that soared on foreign investment start to fall. But none of that means there has been any long-term damage done.

Here are three reasons why:

First, even if there is a crisis in the emerging markets, it will not impact the U.S. or Europe very much. Why? Because they export stuff to us, not the other way around. Take China, for example, by far the biggest of the emerging markets, and a nation that is now a major part of the global economy. Only 0.7% of British GDP is made up of sales to China. In fairness, the British are not very successful in that market. Apart from Land Rovers, we don’t seem to make many things the Chinese want. But it doesn’t matter very much to most developed economies either. Just 0.9% of the U.S. GDP is generated from sales to China, and even for Japan, the figure is only 2.4%. It matters a lot to Australia — 5.8% of its GDP depends on China, nearly all of it raw materials — but to no one else. If China slows down, its factories won’t stop exporting — that will be the only healthy part of the economy. And it won’t make much difference to developed world exports because they are so small. The global economy won’t feel much impact from a Chinese slowdown — and a lot less than people fear.

Second, the currency collapses are part of the solution, not a problem in itself. Take Turkey, for example. It is one of the most successful emerging markets of the last decades, with the kind of rapid growth rate that has enabled it to triple income per capita in only a decade. But as foreign money has flooded in, a big trade deficit has opened up, and with the currency dropping that may be hard to finance.

South Africa is a similar story, although with less rapid growth. But hold on. Where there is a trade deficit, a devaluation of the currency is the simplest solution, at least according to every economics text book I have ever seen. As the currencies of countries like Turkey, South Africa and indeed Argentina slide, exports should increase. That will strengthen their economies over the medium-term, not weaken them.

Finally, growth in the emerging markets is not slowing down — it is accelerating. The IMF last week forecast the emerging markets would grow at 5.1% this year, compared with 4.7% in 2013. China is expected to grow at 7.7% this year — hardly a crisis by anyone’s standards. Even hard-hit Turkey is expected to expand by 4% over the next twelve months. Too optimistic? Not really. The euro-zone has stabilized, at least for the time being, which will help Eastern Europe and Russia and Turkey. The U.S. is growing faster than at any time since the crash, which will help South America. So long as China can stay on course, it will carry on lifting the whole of Asia. Emerging Africa remains one of the fastest-growing regions in the world, and shows few signs of slowing down.

True, a panic in the emerging markets may hit the financial sector. No one would be very surprised to learn that a hedge fund — or a German bank — had been burnt investing in high-yield Turkish debt, or some Argentinian currency derivative so complex no one can understand it. As countries industrialize there will always be wobbles along the way. But if the weakness persists there will be buying opportunities, and smart investors will take them.

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